Population Aging, Foreign Direct Investment, and Tax Competition

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Davies, Ronald B.

Reed, Robert R. (Robert Ray), 1970-

Abstract

This paper studies the role of population aging for foreign direct investment
and the strategic taxation of capital. Importantly, our theoretical model suggests that the
labor market implications of aging differ from the financial market aspects. While
population aging may be associated with a lower capital stock in the home country and
less foreign direct investment, the effects through the labor market and employment tend
to generate larger outbound capital flows. To quantify these aspects, we conduct
regression analysis to empirically document how population aging affects FDI. To be
specific, we use data on both US inbound and outbound FDI. Notably, the estimates
between the US and other developed countries conform quite closely to the predictions of
our theory. We conclude by studying the strategic taxation of capital. In particular, we
examine this issue in light of the fiscal burden associated with older populations. In
contrast to previous work on tax competition, we incorporate that old-age transfer
programs are generally funded by labor taxes. In this manner, our framework introduces
new insights regarding the incentives for governments to restrict capital outflows since
doing so increases the labor income tax base used for intergenerational transfers.

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